Looks like Fred Goodwin may face criminal charges after all

December 14th, 2011

An edited version of this blog post is available at Huffington Post UK

The FSA spent an estimated £10m on its report into the failure of RBS, including £7.7m paid to ‘Big Four’ accountants PWC. But the Canary Wharf-based regulator has lived up to its name (the Fundamentally Supine Authority) and concluded that noone at the the bank nor at its advisers deserves to be punished, since none actually broke any rules.

In an interview with STV News, the FSA chairman Lord Turner said that, within the existing rules, noone was criminally responsible for the RBS collapse; he said all they did was make a few regrettable decisions. Turner also suggested that it might be worth considering changing the rules.

Some have likened the FSA’s stance to the Speer defence, used by Adolf Hitler’s favourite architect, Albert Speer, at the Nuremberg trials in 1945-46 – i.e. lots of bad stuff was going on (reckless lending, reckless takeovers, cluelessness etc) but we (the bankers, the regulators, the government, the advisers, the institutional investors, etc) were all collectively responsible. Lord Turner forcefully told STV:-

“You have to show that they were dishonest, or they lacked integrity, or that their behaviour was outside the bounds of reasonableness, in the circumstances of the time, without applying hindsight.”

Lindsay Thomas an ex-director of the FSA last week told me that the FSA report really needs to be read with an eye for what may have been taken out. Under a process known as ‘Maxwellisation’ , the bank’s ex-directors and their solicitors were had the right to review drafts before publication and edit out material they disliked. Also, it has to be remembered that the regulator (which was always a poor choice to investigate banks like RBS and HBOS, given its complicity in their failure) probably chose to self-censor and not to probe the darker corners of the Royal Bank’s activities, for fear of further exposing its own lamentable performance.

So the FSA has focused on the low-hanging fruit, as Thomas predicted. It has made much of the incompetence of RBS’s ex-head of investment banking, Johnny Cameron (who gets 71 mentions in the report, nearly three times more than the next most-mentioned RBS executive). As Thomas predicted, the ABN acquisition also features heavily in the report, receiving 743 mentions. The regulator was sufficiently brave to refer the Royal Bank’s decision to buy ABN Amro without any due diligence, long after official start of the credit crisis, as a “gamble”. But it couldn’t quite summon up the courage to call it a “reckless gamble”.

Following a brief perusal of the report, it does seem that there are certain critical areas that have either been left out or glossed over by the FSA. These include:-

• The allegedly fraudulent misrepresentation, packaging and bundling of hundreds of billions of dollars worth of residential mortgage-backed securities (RMBS) by RBS Greenwich Capital, over which RBS is already being sued for some $10 billion by the Federal Housing Finance Agency, an arm of the US government. It is noteworthy that RBS recently reached a $52m out-of-court settlement with the government of Massachusetts for the selling, financing, packaging and securitization of subprime mortgages. This is exactly the fraudulent activity that London Banker, a former securities regulator and ex-central banker, highlighted in his latest blog (although he was referring to Citigroup).

• The veracity of RBS’s April 2008 rights issue prospectus. While the FSA’s report devotes five pages to this, the regulator fails to address the critical issue of whether the bank deliberately duped investors into injecting a further £12bn into thealready doomed bank through a deliberately deceptive prospectus, and in particular whether the ‘working capital’ statement was fraudulent or negligent (it has to have been one or the other, according to m’ learned friends. The FSA’s take on the matter is the bank had a “bias towards optimism”.

• In its discussion of the rights issue prospectus, the FSA barely mentions the role of the external advisors who helped put the wholly misleading document together. These included solicitors firms Linklaters, Freshfields and Dundas & Wilson, investment banks Goldman Sachs, Merrill Lynch and UBS; and auditors Deloitte. Why not?

• The role of the RBS’s audit committee, as highlighted by Professor Stewart Hamilton in the Sunday Herald last weekend. In the four years prior to its collapse, the bank’s audit committee was chaired by Archie Hunter, a former president of the Institute of Chartered Accountants of Scotland and former senior partner of KPMG in Scotland. According to the Financial Reporting Council, the audit committee of a listed company is supposed to:-

monitor the integrity of the financial statements and other formal statements relating to its financial performance,

review the company’s internal financial controls and internal control and risk management systems;

monitor and review the effectiveness of the company’s internal audit function;

make recommendations to the board in relation to the appointment of the external auditor and to approve remuneration and terms of engagement of the external auditor;

review and monitor the external auditor’s independence and objectivity and the effectiveness of the audit process

develop and implement policy on the engagement of the external auditor to supply non-audit services

report to the board, identifying any matters in respect of which it considers that action or improvement is needed, and making recommendations as to the steps to be taken.

Despite having enjoyed ‘awaydays’ to far-flung corners of Fred’s empire at shareholders’ expense, RBS’s audit committee does not seem to have performed any of these functions particularly well. So why is the committee only mentioned in passing in the report, and why is there is no standalone section analysing its effectiveness? For the record the other two members of RBS’s audit committee at the time of its collapse were the wonderfully-effective ex-Treasury mandarin Sir Steve Robson and ex-JP Morgan investment banker Joe McHale. Yet Hunter, Robson and McHale only receive one mention apiece in the FSA report, and this is part of a list of the directors who led RBS to destruction.

• The possibility that Sir Fred Goodwin sometimes lent large sums of money, into the hundreds of millions of pounds, to the businesses of his friends, and that in some such instances the loans did not pass through RBS’s regular credit vetting and risk management procedures.

• The possibility that Sir Fred Goodwin and other directors were emulating Lord Conrad Black at Hollinger in terms of the lavishness and cost of the perks and benefits to which he felt they felt entitled, including the a reported £100,000 a month spent on chauffeurs, the suite at the Savoy complete with personal valet to look after Fred’s clothes, the fruit flown in from Paris, the pies delivered by Yorke’s of Dundee at dead of night during the bank’s “Mess Dinners”, the alleged abuse of the RBS private jet for private shopping trips to Paris by the spouses of certain executive directors, the helicopter flights that Fred Goodwin took with his boyhood heroes Jack Nicklaus and Jackie Stewart to and from the British Open at Carnoustie, etc, etc, etc.

As I suggested in an earlier blog post (FSA’s cosy deals a travesty of regulation) the report has been shaped by the FSA’s lack of appetite for seeing scalps taken in the banking sector, and almost seems to have been written with this in mind. The lack of hunger for scalp taking is a corollary of the ‘regulatory capture‘ that existed in the UK market in 2002-08 and the FSA’s recognition to go any further than the existing report would have meant it would have been dangerously exposing itself.

It may also be linked to the recent claim from the Paris-based broadcaster and former equities broker Max Keiser that of David Cameron’s government (and presumably its arm’s-length affiliates like the FSA) is keen to preserve London’s status as the “global capital of fraud“.

Thankfully there are some Whitehall departments that do not share the FSA’s apparent penchant for wagon circling and back covering. According to the Daily Telegraph, the Department for Business, Innovation and Skills, led by the coalition government’s Liberal Democrat business secretary Vince Cable, is seeking to press criminal charges on Fred Goodwin and other ex-RBS directors.

Paradoxically, given Fred’s background as a chartered accountant at Touche Ross, this is because the FSA report has revealed that he and his co-directors may have broken the UK’s accounting laws. As Louise Armitstead reports in today’s Telegraph:-

Under the Companies Act, which is different to the FSA’s rule book and policed by the Department of Business (BIS), directors are required to be able to “disclose [their company’s] financial position with reasonable accuracy at any time”. They have to ensure an “adequate record is made and retained… of any expected loss, liability or contingency material to the assessment of the current position.”

The FSA’s report, which has been handed to Mr Cable, suggests RBS directors were in breach of these rules. Investigators found that “RBS appeared uncertain of its capital position at critical times. This included after March 2008.” They said standard information was hard to find. “The Review Team remained unclear about when a final capital position for end-Q1 2008 was settled by the firm,” the report says. “The then RBS Group Finance Director told the Review Team that balance sheet data were not available until three weeks after the month end.”

It concludes: “So, at best, compliance was only established on a retrospective basis. This undermined the ability of the firm to demonstrate compliance with regulatory… requirements. This was an especially serious failing for a firm which had chosen to operate with limited capital headroom, giving it a very low margin for error.”

One source said: “It is clear from the FSA report that RBS neither had accurate or timely information. Some critical information was six months out of date, and it is clear that losses were missing and asset valuations were overly optimistic.”

Hmmm. This could be starting to get a whole lot more interesting. Go Vince!

Note 1: The FSA’s report is far from being a total whitewash. It does have many virtues, including that it sheds new light on many aspects of the scandalous history of RBS, including the bully boy tactics Fred Goodwin seems to have used with the regulator. It is quite stunning that Goodwin would not allow his non-executive directors to meet the financial regulator on a one-to-one basis, despite repeated requests. It will be invaluable reading to anyone who gets around to writing the definitive account of this once proud Scottish icon.

Note 2: Given Lord Turner’s claim that no dishonesty was involved in the bank’s collapse, I’d be interested to know what civil test the FSA applied in adjudicating this result. If the regulator used they Fraud Act 2006 to test for possible dishonesty, it would simply have had to establish whether “what was done was dishonest by the ordinary standards of reasonable and honest people? Must the defendant have realised that what he/she was doing was, by those standards, dishonest?”